Project Analysis Example 3





Kerry Back

  • The XYZ company is considering launching a new product. Sales of the product are expected to rise and then diminish, and it is anticipated that the product will be abandoned after five years.

  • Sales (in millions of dollars) are projected as follows:

Year 0 1 2 3 4 5
100 150 200 120 80
  • The cost of capital is 12%.
  • The corporate tax rate is 30%.

  • Labor and material costs for the product would be 50% of sales revenue.

  • For the first two years, the new product would reduce sales of existing products by $20 million and $10 million, respectively. The existing products have the same 50% gross margin.

  • Incremental selling, general, and administrative expenses are forecast to be (in millions of dollars):

Year 0 1 2 3 4 5
20 25 15 10 5

  • The new product would require an investment of $100 million in 10-year MACRS equipment. The depreciation rates for the first five years are 10%, 18%, 14.4%, 11.52%, and 9.22%.
  • It is anticipated that the equipment could be sold for $60 million in five years.
  • $15 million of materials inventory would be required immediately, and accounts payable would increase by $5 million.
  • Afterwards, receivables would be 8% of sales, inventory would be 20% of COGS, and accounts payable would be 12% of COGS.
  • All working capital would be recovered in five years.